Debt, what is it?
Debt is when you owe anyone money. Any time you don’t pay in full—that’s debt. Are you still making payments for something you bought? Yep, debt. You purchased the nice car before you had the cash. You borrowed from your in-laws because you didn’t have the cash. No matter how you phrase it, debt means you owe someone money.
To start off. The common myth of good debt versus bad debt is just that. A myth. There is no such thing as good debt. Just bad debt and better debt. It’s all debt.
Types of debt
Often considered the worst of the worst type of debt to acquire. Payday loans are a rip off. That’s it. Avoid them. Targeted towards low income earners in low income areas payday loan lenders have a repeat customer rate of up to 80%. A scary figure considering you don’t see much of these types of lenders in the higher income areas.
While it might look like a quick fix, payday loans have a lot of fees. For example, to pay back a $2,000 payday loan over one year, your total repayments will be about $3,360. That’s $1,360 more than you borrowed or a 68% increase!
More information on payday loans: https://moneysmart.gov.au/loans/payday-loans
A credit card is a card that is issued by financial institutions – usually a bank – to their clients. It allows holders to borrow pre-approved funds at the point of sale as a replacement to cash.
Your credit card provider allows you to effectively borrow money with the expectation that you will repay a minimum, partial, or the full amount owing each month. When you do not repay the whole balance, the remaining amount is carried over tand may be subject to an interest charge.
Basically, a credit card is an ongoing loan. Going up and down. Up and down.
Credit cards feature higher annual percentage rates (APRs) than other forms of debt. Interest on the unpaid balance charged to the card is usually charged one month after a purchase is made.
We do not use credit cards ourselves. I have in the past and found it extremely tempting so paid it off and cancelled it as soon as i could. It was not worth having the headache of another form of debt. The theme of financial independence is freedom from all debt types. We are working towards that so a credit card is not necessary.
If you’re looking for a thorough review on credit cards: https://www.canstar.com.au/
More info on credit cards: https://www.creditsavvy.com.au/learn/credit-products/what-you-need-to-know-about-credit-cards
A personal loan is where you borrow a specific amount of money, usually from a financial institution, and then repay the debt with interest in equal payments over an agreed term.
Personal loans offer the general advantages of being cheaper on average than credit cards and give the borrower the discipline of scheduled repayments.
With a fixed interest rate, your repayments won’t change over the loan term. You’ll know exactly how much will come out through your direct debit each payment cycle.
With a variable interest rate, your repayments will change if and when interest rates change. If interest rates go up, your repayments will be higher. If interest rates fall, your repayments will.
-Personal loans can be secured or unsecured.
With a secured loan you provide an asset, such as your car, as security for the loan. If you don’t pay the loan back on time, the lender has legal right to repossess it to pay for the amount owing.
With an unsecured loan, you don’t have to provide an asset as security. But the interest rate will be higher, and in some cases you may need a loan guarantor. If you fail to pay back the loan, the lender can still take you to court to get back the money you borrowed.
Making extra repayments on top of the minimum every month is the best way to pay down a personal loan quicker. By paying extra you are paying the principal amount of the loan not the interest as your regular repayments are split between. Paying the loan off faster means paying less interest, saving money.
We are currently in the process of paying down personal loan debts and it is satisfying to see the amount go down quicker as compared to just paying the minimum.
More info on personal loans: https://www.canstar.com.au/personal-loans/what-is-a-personal-loan/
A car loan is a personal loan for a new or used car. You have to repay the loan and interest over a fixed term, usually between one and seven years.
These loans may be secured or unsecured.
A secured loan is one where you offer collateral to provide more security to the loan provider in case you fail to repay the money you have borrowed within the loan timeframe. If the sale of your collateral does not cover the full amount you owe, you will have to pay what is left directly to the lender.
Unsecured loans, on the other hand, do not require any collateral. Instead, the lender will rely on your credit score. Unsecured loans generally have higher interest rates than secured loans and you may not be able to borrow as much.
Car loans are tricky for some people. On one hand you convince yourself you ‘need’ that shiny car in the lot and therefore need the loan. One the other it is more than you can afford in cash so you acquire more debt to acquire the car.
A car is not an asset. Once you drive the car off the lot it depreciates in value. You are paying a specified loan amount on a depreciating asset.
Purchasing a vehicle cash is a better option where possible. Avoid the debt and interest. Consider purchasing a lower priced car that you can afford to buy without incurring the debt.
A more in depth look at car loans: https://moneysmart.gov.au/loans/car-loans
A student loan is a type of loan designed to help students pay for post-secondary education and the associated fees, such as tuition, books and supplies, and living expenses.
It may differ from other types of loans in the fact that the interest rate may be substantially lower and the repayment schedule may be deferred while the student is still in school.
Tertiary student places in Australia are usually funded through the HECS-HELP scheme. This funding is in the form of loans that are not normal debts. They are repaid over time via a supplementary tax, using a sliding scale based on taxable income. As a consequence, loan repayments are only made when the former student has income to support the repayments. Discounts are available for early repayment. (ref. wikipedia)
These types of loans are for most tertiary students in Australia seen as compulsory. As the majority of students do not have the funds upfront to pay for their chosen studies they incur this debt.
This debt is designed to help people unlike most debts. Students do not need to pay it back until they reach a certain income threshold after they have finished studying.
For more info on Australian student loans: https://www.studyassist.gov.au/help-loans/hecs-help
Mortgages (for your home)
A mortgage is a type of loan used to purchase real estate. A mortgage is usually used to finance a home or an investment property when you can’t pay the entire cost upfront. Paying back the loan, with interest and principal, over a period of time through a series of repayments typically over 15 or 30 years. The lender is usually listed on the title of the property until the borrower repays the entire loan.
The average Sydney mortgage now weighs in at $365,873 across all mortgage-holding households. (ref.)
Mortgages (for your Rental Property)
With much the same definition as a regular mortgage. This type of mortgage is simply a debt that is paid for by the tenants of your property. Your investment property. It becomes fully self sustaining with the tenants covering the repayments of your debt as well as the up keep of the property.
The debt is being paid for by someone else entirely. This would be one of the ‘better’ types of debt I mentioned at the start.
Family or Friend loans
Who hasn’t borrowed money from a family member or friend before?
In most situations these debts don’t have any interest applied however in many cases they do put a strain on relationships. Avoiding this type of debt is essential to good relationships.
When you borrow from someone you’re close to, typically no one signs a contract. You probably won’t discuss the repayment terms other than ‘pay me when you’re back on your feet’ but that doesn’t mean this debt has no risks.
Ask for a loan from friends or family only after exhausting all other options. That is if you absolutely need debt in the first place. Which most of the time you don’t.
The 8 types of debt. All having their own associated risks, interests and costs.
Evaluating and understanding your existing debt can be a daunting task.
Incurring more debt in any form is a step backwards. Seeking a plan to pay off debt early will benefit you in the long run tenfold. We are only just beginning this path to be debt free ourselves. We will post another article detailing our early debt pay off plan in the coming days. start with this!
There is no such thing as bad and good debt. Only bad and ‘better’ debt.
In its raw definition, debt is still just ‘a sum of money that is owed or due.’
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.